How would you expect markets to react to a conflagration on the Korean peninsula?
A military option to resolving the situation in North Korea is theoretically possible but the impact of a conflagration on the Korean peninsula is almost unthinkable. The ballistic and nuclear capabilities aside, the North Korean conventional forces are enormous. Seoul, a South Korean city with a population of 24 million, is about 20 miles from the border and well within range of the conventional forces. Deaths on both sides could run into hundreds of thousands, if not millions. It is possible that the conflagration could be contained but the likelihood is that it would be more widespread. The Chinese do not want US military forces on their southern border and see North Korea as a buffer between them and the US in South Korea.
Trumps fire and fury rhetoric does not help what is already a tense situation and Rex Tillerson has moved to try and calm things down. The latest UN sanctions need time to bring pressure on the North but in the end, it is the Chinese rather than the Americans who can resolve the situation if they choose to. The Chinese buy coal from North Korea and supply oil and petrol to them so have significant leverage over the rogue state. We should remember there are an estimated 800,000 Chinese people in South Korea which may be an added incentive to avoid a conflict.
However, to return to the question at hand, what would be the impact should the worst happen? I would expect equity markets to fall, particularly in the Far East, a flight into the dollar, Swiss franc, gold and high quality government bonds. However, this is an extreme scenario and is certainly not our base case. We should all hope for a peaceful solution. The recent sharpening of rhetoric has caused some market movement but at this time it is a far cry from panic, perhaps reflecting the belief that a larger escalation is in no one’s best interest.
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